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American Express to Hike Dividend: Better Days Ahead?

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American Express Co. (AXP - Free Report) disclosed that the Board of Governors of the Federal Reserve System has waved a green flag to the company’s capital plan submitted on Apr 5. The plan submission was part of the 2016 Comprehensive Capital Analysis and Review (CCAR).

Notably, CCAR is a regulatory framework of the Federal Reserve which assesses, regulates and supervises large banks and financial institutions.

The passage of the capital plan by American Express signifies that the company possesses adequate capital and that its capital structure is stable under various stress-test scenarios. It also implies that planned capital distributions, such as dividends and share repurchases, are viable and acceptable in relation to the regulatory body’s minimum capital requirements.

American Express investors will now receive an increased dividend of 32 cents per share, which translates into a hike of 10% over the previous dividend payout. The company will also buy back up to $3.3 billion of common shares during the CCAR approval period of the third quarter of 2016 to the second quarter of 2017.

The company will most likely use excess capital generated from the sale of its Costco co-brand card portfolio for dividend payment and share buyback.

While the company has passed its capital strength test and has brought investors some much-needed relief, other fundamental and economic troubles facing the company continue to bother.

Fundamental Problems at American Express

The company’s earnings and consequently its share price have been dragged down by bearish sentiments that engulfed the company from the loss of its contract with retail prime Costco Wholesale Corp. The contract's termination, which was disclosed last year, prompted the company to spend heavily on growth initiatives so as to counter the loss from the Costco partnership. Increased expenditure on growth initiatives dragged down the company’s bottom line.

Earnings have also been stressed by co-brand renewal cost (Starwood, Delta and others). Both these factors will continue to haunt results this year too.
 
On the competitive front, the company remains challenged by continued innovation within the payments’ industry. Alternative payment methods such as mobile technologies also pose threats to growth. Moreover, players like MasterCard Incorporated (MA - Free Report) and Visa Inc. (V - Free Report) pose stiff competition.  

Regulatory Issues
 
The Department of Justice ruled against American Express in a suit that challenged the company's rules that allow merchants to promote other cards as anticompetitive. American Express is appealing the decision, and this process could take considerable time. If the company loses the appeal, it could be damaging to its payment market share and transaction fees.

Macroeconomic Headwinds

American Express has been bearing the burnt of a strong dollar since 2015. The dollar strength had a significant adverse impact on its cross border revenues and reduced earnings per share by about 3% to 4% in 2015. The company also commented that dollar strength can impact its 2016 earnings. Apart from currency woes, a weak global economy also hindered the company’s growth by limiting overall spending of consumers. The price of oil and its downstream impact on airfare and gasoline prices created a drag on charge volume, which compressed the top line.

Now Brexit Woes

While there is very little direct impact of Brexit on American Express since the company has very low earnings exposure to the region, indirect effects cannot be ruled out. Britain’s unprecedented decision to leave the European Union pushed the pound down to its lowest level in 30 years, while Euro also saw a decline against the U.S. dollar. The strengthening dollar will affect American Express’ cross-border business volume. Exchange rates were a troubling factor for American Express in 2015, and now with Brexit, it will not see any respite from currency headwinds anytime soon.

Another fear is that Brexit may push the U.S. into a recession which will lower card spending volume and weigh down on the company’s business growth.

Initiatives to Accelerate Growth at American Express

American Express announced steps to boost its profitability. These initiatives include management reshuffling, simplifying processes across businesses and a reduction in expenses to the tune of $1 billion over the next two years. Through these measures the company intends to improve revenues, optimize investments and reduce expense.

Will American Express be able to Appease Investors?

Though the company has passed the stress test and will initiate a dividend increase and share buyback, pointing to its balance sheet soundness, investors will continue to monitor the company’s financial performance until it shows actual progress in addressing the core issues facing it.

Other card issuers Capital One Financial Corporation (COF - Free Report) and Discover Financial Services (DFS - Free Report) also underwent CCAR and received non-objection from Federal Reserve with respect to their proposed capital actions.

Currently, American Express carries a Zacks Rank #3 (Hold).

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